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Aug 28 (The following statement was released by the rating agency)
Fitch Ratings has affirmed OJSC Rostelecom's Long-term Issuer Default Rating (IDR) at 'BBB-' with a Stable Outlook. A full list of rating actions is at the end of this comment.
Rostelecom is the Russian fixed-line incumbent operator benefiting from only limited facilities-based competition and benign regulatory environment. It is a strategic asset for the government and the company's ratings benefit from one notch for potential support.
KEY RATING DRIVERS
Established Incumbent Status
Rostelecom holds a strong incumbent position in the traditional voice fixed-line segment, complemented by its broadband market leadership. Given the lack of local loop unbundling, the company's fixed-line market shares are likely to be preserved. The key risk is fixed-line customer disconnections, which Fitch expects to remain moderate compared with its European peers.
Evolving Mobile Strategy
Rostelecom is only a niche player in the mobile market but is a prime candidate to participate in industry consolidation. Teaming up with Tele2 Russia will likely create a stronger market player and will help address the scale issue. Either teaming with Tele2 Russia or maintaining standalone operations, Rostelecom would need substantial capex to reduce a capacity and coverage gap with its larger mobile peers, particularly in data.
A potential acquisition of Tele2 Russia would be treated by Fitch as an event risk. We estimate that with a degree of financial prudence, the impact of this acquisition on leverage may be tolerated within the current ratings.
Positive Regulatory Environment
We view the current regulatory environment in Russia as generally benign for the incumbent operator and expect it to remain so. Although the regulator is sympathetic towards providing non-discriminatory access to the incumbent's network, the practical implementation of this may not be easily achievable. The introduction of mobile number portability will likely benefit smaller players including Rostelecom.
Potential State Support
Rostelecom's IDR factors in a one-notch uplift for potential sovereign support, as strategic and operational ties with the government are viewed by Fitch as reasonably strong. Rostelecom remains a key infrastructure provider to the Russian military and a key contractor in other large-scale projects, such as "digital government", and the provision of universal services. The government is likely to let Rostelecom pay only modest dividends prioritising infrastructure investments.
The company's leverage is moderate with net debt/EBITDA at 1.7x and FFO adjusted net leverage at 2.1x at end-2012. Fitch expects leverage to rise to 1.9x-2.0x by end-2013 due to high capital expenditure and a share buy-back. Organic development is unlikely to push leverage to above 2x, although this may be compromised by acquisitions.
Improved Liquidity and Maturity Profile
Rostelecom's current maturity profile is reasonably well-spread. At end-June 2013, 24% of the company's debt was short term, a significant improvement from 47% at end-2011. We understand the company is planning to maintain an approximate 25/75 split between short- and long-term debt. By our estimates, the company has sufficient liquidity to finance share buy-backs in conjunction with the Svyazinvest acquisition and cover over 12 months of coming debt maturities as of end-H113.
Positive rating changes are unlikely unless the company manages to develop successful and profitable mobile operations without compromising the group's leverage, which is only potentially achievable in the medium to long term. 'BBB-' is viewed as a cut-off level for factoring in government support, and therefore a potential improvement in Rostelecom's standalone credit profile to 'BBB-' would not be accompanied by an upgrade.
Leverage of up to 3.5x FFO adjusted net leverage may be accommodated within the current rating, provided that Rostelecom's maturity profile is well spread and its liquidity situation is strong, the company retains solid FCF generation with a pre-dividend FCF margin of at least 5%, which is not compromised by excessive shareholder remuneration. Alternatively, depressed pre-dividend free cash flow generation due to high capex would have to be remedied through a modest dividend pay-out.
FULL LIST OF RATING ACTIONS
Long-Term IDR: affirmed at 'BBB-', Outlook Stable
National Long-Term Rating: affirmed at 'AA+(rus)', Outlook Stable
Senior unsecured: affirmed at 'BBB-' and 'AA+(rus)